2–1
CHAPTER 2
AN INTRODUCTION TO COST TERMS AND PURPOSES
2–1 A cost object is anything for which a separate measurement of costs is desired. Examples
include a product, a service, a project, a customer, a brand category, an activity, and a
department.
2–2 Direct costs of a cost object are related to the particular cost object and can be traced to
that cost object in an economically feasible (cost–effective) way.
Indirect costs of a cost object are related to the particular cost object but cannot be traced
to that cost object in an economically feasible (cost–effective) way.
Cost assignment is a general term that encompasses the assignment of both direct costs
and indirect costs to a cost object. Direct costs are traced to a cost object while indirect costs are
allocated to a cost object.
2–3 Managers believe that direct costs that are traced to a particular cost object are more
accurately assigned to that cost object than are indirect allocated costs. When costs are allocated,
managers are less certain whether the cost allocation base accurately measures the resources
demanded by a cost object. Managers prefer to use more accurate costs in their decisions.
2–4 Factors affecting the classification of a cost as direct or indirect include
the materiality of the cost in question,
available information–gathering technology,
design of operations
2–5 A variable cost changes in total in proportion to changes in the related level of total
activity or volume. An example is a sales commission that is a percentage of each sales revenue
dollar.
A fixed cost remains unchanged in total for a given time period, despite wide changes in
the related level of total activity or volume. An example is the leasing cost of a machine that is
unchanged for a given time period (such as a year) regardless of the number of units of product
produced on the machine.
2–6 A cost driver is a variable, such as the level of activity or volume, that causally affects
total costs over a given time span. A change in the cost driver results in a change in the level of
total costs. For example, the number of vehicles assembled is a driver of the costs of steering
wheels on a motor–vehicle assembly line.
2–7 The relevant range is the band of normal activity level or volume in which there is a
specific relationship between the level of activity or volume and the cost in question. Costs are
described as variable or fixed with respect to a particular relevant range.
2–8 A unit cost is computed by dividing some amount of total costs (the numerator) by the
related number of units (the denominator). In many cases, the numerator will include a fixed cost
that will not change despite changes in the denominator. It is erroneous in those cases to multiply
the unit cost by activity or volume change to predict changes in total costs at different activity or
volume levels.
© 2012 Pearson Education, Inc. Publishing as Prentice Hall. SM Cost Accounting 14/e by Horngren
2–2
2–9 Manufacturing–sector companies purchase materials and Ashtonnents and convert them
into various finished goods, for example automotive and textile companies.
Merchandising–sector companies purchase and then sell tangible products without
changing their basic form, for example retailing or distribution.
Service–sector companies provide services or intangible products to their customers, for
example, legal advice or audits.
2–10 Manufacturing companies have one or more of the following three types of inventory:
1. Direct materials inventory. Direct materials in stock and awaiting use in the
manufacturing process.
2. Work-in–process inventory. Goods partially worked on but not yet completed. Also
called work in progress.
3. Finished goods inventory. Goods completed but not yet sold.
2–11 Inventoriable costs are all costs of a product that are considered as assets in the balance
sheet when they are incurred and that become cost of goods sold when the product is sold. These
costs are included in work–in–process and finished goods inventory (they are ―inventoried‖) to
accumulate the costs of creating these assets.
Period costs are all costs in the income statement other than cost of goods sold. These
costs are treated as expenses of the accounting period in which they are incurred because they are
expected not to benefit future periods (because there is not sufficient evidence to conclude that
such benefit exists). Expensing these costs immediately best matches expenses to revenues.
2–12 Direct material costs are the acquisition costs of all materials that eventually become part
of the cost object (work in process and then finished goods), and can be traced to the cost object
in an economically feasible way.
Direct manufacturing labor costs include the compensation of all manufacturing labor
that can be traced to the cost object (work in process and then finished goods) in an economically
feasible way.
Manufacturing overhead costs are all manufacturing costs that are related to the cost
object (work in process and then finished goods), but cannot be traced to that cost object in an
economically feasible way.
Prime costs are all direct manufacturing costs (direct material and direct manufacturing
labor).
Conversion costs are all manufacturing costs other than direct material costs.
2–13 Overtime premium is the wage rate paid to workers (for both direct labor and indirect
labor) in excess of their straight–time wage rates.
Idle time is a subclassification of indirect labor that represents wages paid for
unproductive time caused by lack of orders, machine breakdowns, material shortages, poor
scheduling, and the like.
2–14 A product cost is the sum of the costs assigned to a product for a specific purpose.
Purposes for computing a product cost include
pricing and product mix decisions,
contracting with government agencies, and
preparing financial statements for external reporting under generally accepted
accounting principles.
© 2012 Pearson Education, Inc. Publishing as Prentice Hall. SM Cost Accounting 14/e by Horngren
2–3
2–15 Three common features of cost accounting and cost management are:
calculating the costs of products, services, and other cost objects
obtaining information for planning and control and performance evaluation
analyzing the relevant information for making decisions
2–16 (15 min.) Computing and interpreting manufacturing unit costs.
1.
(in millions)
Supreme Deluxe Regular Total
Direct material cost $ 89.00 $ 57.00 $60.00 $206.00
Direct manuf. labor costs 16.00 26.00 8.00 50.00
Manufacturing overhead costs 48.00 78.00 24.00 150.00
Total manuf. costs 153.00 161.00 92.00 406.00
Fixed costs allocated at a rate
of $15M $50M (direct mfg.
labor) equal to $0.30 per
dir. manuf. labor dollar
(0.30 $16; 26; 8) 4.80 7.80 2.40 15.00
Variable costs $148.20 $153.20 $89.60 $391.00
Units produced (millions) 125 150 140
Cost per unit (Total manuf.
costs ÷ units produced) $1.2240 $1.0733 $0.6571
Variable manuf. cost per unit
(Variable manuf. costs
Units produced) $1.1856 $1.0213 $0.6400
(in millions)
Supreme Deluxe Regular Total
2. Based on total manuf. cost
per unit ($1.2240 150;
$1.0733 190; $0.6571 220) $183.60 $203.93 $144.56 $532.09
Correct total manuf. costs based
on variable manuf. costs plus
fixed costs equal
Variable costs ($1.1856 150; $177.84 $194.05 $140.80 $512.69
$1.0213 190; $0.64 220)
Fixed costs 15.00
Total costs $527.69
The total manufacturing cost per unit in requirement 1 includes $15 million of indirect
manufacturing costs that are fixed irrespective of changes in the volume of output per month,
while the remaining variable indirect manufacturing costs change with the production volume.
Given the unit volume changes for August 2011, the use of total manufacturing cost per unit
from the past month at a different unit volume level (both in aggregate and at the individual
product level) will overestimate total costs of $532.09 million in August 2011 relative to the
correct total manufacturing costs of $527.69 million calculated using variable manufacturing cost
per unit times units produced plus the fixed costs of $15 million.
© 2012 Pearson Education, Inc. Publishing as Prentice Hall. SM Cost Accounting 14/e by Horngren
2–4
2–17 (15 min.) Direct, indirect, fixed and variable costs.
1. Yeast – direct, variable
Flour– direct, variable
Packaging materials –direct (or could be indirect if small and not traced to each unit), variable
Depreciation on ovens –indirect, fixed (unless ―units of output‖ depreciation, which then
would be variable)
Depreciation on mixing machines–indirect, fixed (unless ―units of output‖ depreciation, which
then would be variable)
Rent on factory building – indirect, fixed
Fire Insurance on factory building–indirect, fixed
Factory utilities – indirect, probably some variable and some fixed (e.g. electricity may be
variable but heating costs may be fixed)
Finishing department hourly laborers – direct, variable (or fixed if the laborers are under a
union contract)
Mixing department manager – indirect, fixed
Materials handlers –depends on how they are paid. If paid hourly and not under union
contract, then indirect, variable. If salaried or under union contract then indirect, fixed
Custodian in factory –indirect, fixed
Night guard in factory –indirect, fixed
Machinist (running the mixing machine) –depends on how they are paid. If paid hourly and
not under union contract, then indirect, variable. If salaried or under union contract
then indirect, fixed
Machine maintenance personnel – indirect, probably fixed, if salaried, but may be variable if
paid only for time worked and maintenance increases with increased production
Maintenance supplies – indirect, variable
Cleaning supplies – indirect, most likely fixed since the custodians probably do the same
amount of cleaning every night
2. If the cost object is Mixing Department, then anything directly associated with the Mixing
Department will be a direct cost. This will include:
Depreciation on mixing machines
Mixing Department manager
Materials handlers (of the Mixing Department)
Machinist (running the mixing machines)
Machine Maintenance personnel (of the Mixing Department)
Maintenance supplies (if separately identified for the Mixing Department)
Of course the yeast and flour will also be a direct cost of the Mixing Department, but it is already
a direct cost of each kind of bread produced.
© 2012 Pearson Education, Inc. Publishing as Prentice Hall. SM Cost Accounting 14/e by Horngren
2–5
2–18 (15–20 min.) Classification of costs, service sector.
Cost object: Each individual focus group
Cost variability: With respect to the number of focus groups
There may be some debate over classifications of individual items, especially with regard
to cost variability.
Cost Item
D or I
V or F
A
D
V
B
I
F
C
I
Va
D
I
F
E
D
V
F
I
F
G
D
V
H
I
Vb
aSome students will note that phone call costs are variable when each call has a separate charge. It may be a fixed
cost if Consumer Focus has a flat monthly charge for a line, irrespective of the amount of usage.
bGasoline costs are likely to vary with the number of focus groups. However, vehicles likely serve multiple
purposes, and detailed records may be required to examine how costs vary with changes in one of the many
purposes served.
2–19 (15–20 min.) Classification of costs, merchandising sector.
Cost object: Videos sold in video section of store
Cost variability: With respect to changes in the number of videos sold
There may be some debate over classifications of individual items, especially with regard
to cost variability.
Cost Item
D or I
V or F
A
D
F
B
I
F
C
D
V
D
D
F
E
I
F
F
I
V
G
I
F
H
D
V
© 2012 Pearson Education, Inc. Publishing as Prentice Hall. SM Cost Accounting 14/e by Horngren
2–6
2–20 (15–20 min.) Classification of costs, manufacturing sector.
Cost object: Type of car assembled (Corolla or Geo Prism)
Cost variability: With respect to changes in the number of cars assembled
There may be some debate over classifications of individual items, especially with regard
to cost variability.
Cost Item
D or I
V or F
A
D
V
B
I
F
C
D
F
D
D
F
E
D
V
F
I
V
G
D
V
H
I
F
2–21 (20 min.) Variable costs, fixed costs, total costs.
1.
Minutes/month
0
50
100
150
200
240
300
327.5
350
400
450
510
540
600
650
Plan A ($/month)
0
5
10
15
20
24
30
32.75
35
40
45
51
54
60
65
Plan B ($/month)
15
15
15
15
15
15
19.80
22
23.80
27.80
31.80
36.60
39
43.80
47.80
Plan C ($/month)
22
22
22
22
22
22
22
22
22
22
22
22
23.50
26.50
29
0
10
20
30
40
50
60
0100 200 300 400 500 600
Total Cost
Number of long-distance minutes
Plan A
Plan B
Plan C
2. In each region, Ashton chooses the plan that has the lowest cost. From the graph (or from
calculations)*, we can see that if Ashton expects to use 0–150 minutes of long–distance each
month, she should buy Plan A; for 150–327.5 minutes, Plan B; and for over 327.5 minutes,
Plan C. If Ashton plans to make 100 minutes of long–distance calls each month, she should
choose Plan A; for 240 minutes, choose Plan B; for 540 minutes, choose Plan C.
*Let x be the number of minutes when Plan A and Plan B have equal cost
$0.10x = $15
x = $15 ÷ $0.10 per minute = 150 minutes.
Let y be the number of minutes when Plan B and Plan C have equal cost
$15 + $0.08 (y – 240) = $22
$0.08 (y – 240) = $22 – $15 = $7
y – 240 =
$7 87.5
$0.08
y = 87.5 + 240 = 327.5 minutes
© 2012 Pearson Education, Inc. Publishing as Prentice Hall. SM Cost Accounting 14/e by Horngren
2–22 (15–20 min.) Variable costs and fixed costs.
1. Variable cost per ton of beach sand mined
Subcontractor $ 80 per ton
Government tax 50 per ton
Total $130 per ton
Fixed costs per month
0 to 100 tons of capacity per day = $150,000
101 to 200 tons of capacity per day = $300,000
201 to 300 tons of capacity per day = $450,000
2.
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